How to Make 900% Gains, Tax Free

This is my least favorite time of the year.

No, it’s not my birthday, or a holiday where I have to spend endless hours with distant family members.

And I doubt I’m alone on this one…

This particular time of year brings a collective groan across the United States.

That’s right, folks…

It’s tax season.

Don’t get me wrong. I don’t have any philosophical issues with paying taxes.

It’s just that the amount they take always seems to come as a surprise. An unpleasant one at that.

And while taxes on long-term gains from start-up investments are relatively low, wouldn’t it be great if there were a way to avoid those taxes entirely?

Or at least defer them?

As it turns out, there is a way – in fact, there are three ways.

If you own QSBS and the company is acquired, there’s a way to defer paying taxes on the gain…

Today I’ll walk you through each of them…

First… Have you ever heard of “Qualified Small Business Stock” (or, QSBS)?

Most folks haven’t – including professional investors.

Basically, stock is considered QSBS if the entire company is worth less than $50 million at the time of your investment.

Since most early-stage companies are valued at far less than $50 million, there’s a good chance the investors are getting QSBS.

But let’s say, sometime further down the road, the company is doing well and generating tens of millions in revenues. At this point, the company might be valued far more richly – let’s say $100 million.

If you invest at this stage, you would not own QSBS.

But here’s where this gets interesting from a tax perspective…

If you own QSBS and the company is acquired, there’s a way to defer paying taxes on the gain…

Just invest your profits into another early-stage investment – one that’s worth less than $50 million!

In other words, if you use your profit to buy more Qualified Small Business Stock you don’t have to pay taxes on the initial gain.

Let’s look at an example:

Let’s say you invested in a start-up a few years ago. You put in $10,000 for a 10% stake in the company.

The startup was recently acquired for $1 million.  Backing out your original investment, it nets you a profit of $90,000 (a 900% gain).

If you take that $90,000 and invest it into another start-up (or several start-ups), no taxes are due.

In addition to tax deferment, the tax code also provides you with a way to avoid paying taxes on your QSBS gains entirely… if certain conditions are met.

Basically, you can avoid paying taxes on a large portion of your gains as long as you’ve held the stock for at least 5 years.

Let’s use the same example above:

If you have a gain of $90,000 on QSBS that you’ve held for longer than 5 years, you could potentially avoid paying capital gains taxes on 75% to 100% of the gain… even if you don’t roll it over.

You’ll need to work with your accountant to determine the exact amount.

At this point I’m sure you’re asking, “But what happens if the stock I’m investing in doesn’t qualify as QSBS? Am I still stuck paying the full freight on my gains?”

The short answer: Yes.

You still have to pay taxes on your gains for non-QSBS profits.

Longer answer:  You don’t have to pay Uncle Sam right now.

Luckily, many IRA providers are starting to recognize that Equity Crowdfunding is here to stay.

How?

By using your IRA to invest in these deals.

To be clear, not all IRA providers (e.g. Charles Schwabb) will allow you to hold private equity in your IRA. So you’ll need to check with your current IRA provider first.  Simply give them a call, explain that you’re trying to invest in a private company through your IRA and someone will be able to give you an answer pretty quickly.

Luckily, many IRA providers are starting to recognize that Equity Crowdfunding is here to stay. They realize that investors are interested in making this new asset class a permanent part of their portfolio.

So providers are now making it very easy for investors to hold private equity in their self-directed IRA accounts.

A few of the more popular providers focused on equity crowdfunding include: Kingdom Trust, Entrust and Sterling Trust.

Investing via your IRA will allow gains to accumulate tax deferred until you withdraw the capital. At that point they’ll be taxed as income.

Obviously investing in early-stage, private companies can be risky business. This isn’t an asset class you want to put your entire IRA in.

However, as we’ve said before, investing in start-ups is a fantastic way to diversify your portfolio into a new, exciting asset class. You just need to do it in a smart way.

And avoiding taxes along the way sounds pretty smart to me.

Happy investing!

Best Regards,

Wayne Mulligan
for The Daily Reckoning

Ed. Note: Wayne’s advice offers a great way around some of the IRS’ ludicrous regulation. But there are plenty of great ways to keep the tax man’s grubby hands out of your pocket. And in today’s issue of Tomorrow in Review, readers were given a chance to discover one of the most incredible ways to do just that – including one form that could help them save as much as $18,000 on their taxes this year. It’s just one small benefit of being a subscriber to the FREE Tomorrow in Review email edition. Sign up for FREE, right here, and never miss another great opportunity like this.

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